I referred last week to views expressed by Richard Woolnough, part of a team that manages more than £20bn in bond funds at M&G. The sheer size of the three funds he runs says a great deal about how highly he is regarded in the adviser and discretionary fund manager community, as well as reminding us how dramatically portfolio construction has changed over the last generation.
When I first started advising private investors, bond diversification involved holding the odd gilt-edged security or two. Investing overseas was too expensive and corporate bonds were viewed as an area of activity for professional investors. I cannot recall there being any bond funds in which to tuck client money away to benefit from the attention of an experienced and knowledgeable manager.
And knowledgeable sums up Woolnough. There was a good turnout to hear his views on fixed interest markets.
Two opinions emerged that gave me food for thought. First, he believes the single currency zone must eventually fall apart. Second, he does not see interest rates returning to their pre-financial crisis levels for some time. He was honest enough to admit he could be wrong on both counts but the arguments were compelling.
Whereas a few years ago, before the stresses in our financial structures were exposed, those with money to lend within the eurozone placed them with whichever provided the best return. The risks between borrowers seemed even. Not so today, when money flows to the perceived least risky institutions, such as the Bundesbank.
Those that need the money find it difficult to access and pay through the nose. Those without the need to borrow have it in abundance at sensible rates. Their only real option is to recycle it, which adds a whole new layer of risk.
Moreover, those stronger countries with the lowest unemployment rates have the lowest interest rates and are able to adopt looser monetary policy. Countries with high unemployment are constrained by a lack of freedom on the monetary front.
This point was brought home after the meeting by the downgrading of Spain’s debt by two notches and the announcement that unemployment had risen further to within a whisker of 25 per cent.
Germany, in contrast, has the lowest unemployment rate in the eurozone at around 7 per cent. Remarkably, when the financial crisis first arrived in 2007, Germany had the highest – a position it had held for the previous two years.
What does all this mean for investors? According to Woolnough, it depends on how swiftly it is sorted out.
A long drawn-out affair will be economically damaging. Tackling it early might be painful in the short term but at least the problem can be put behind those nations bound together by a currency that is the problem rather than the solution.
As for interest rates, Woolnough’s contention that the Bank of England is now more concerned with the health of the financial system and the restoration of economic growth has convinced him that any increase in interest rates will be some way off and modest.
Inflation is now less of a concern. It seems members of the monetary policy committee have been mightily affected by learning how close RBS and HBOS came to switching off cash machines.
Bond markets dwarf equities – something many investors tend to forget – and the whole capitalist system depends on debt. The problem is that we are going to have to get used to relying on it less in the developed world.
Correcting the balance will not be easy but it will create opportunities for managers such as Richard and the rest of his team. It is a pity they were not around when I started out.
Brian Tora is an associate with investment manager JM Finn & Co